The rhetorical question – Do corporate boards of directors represent management or shareholders? – is worth re-asking. We know what the answer should be; however, too often boards cater to the demands of management, at the expense of shareholders.

Last week, William Chandler of Delaware’s Court of Chancery upheld Airgas’ “poison pill” provision, a mechanism for diluting the shares held by what the board deems a hostile acquirer. The fact that Airgas has a staggered, or classified, board (in which one third of the directors are elected every year for a three-year term) aggravated the situation for the management of Air Products, but more importantly for the shareholders of Airgas. (Staggered, as opposed to unitary, or annually elected, boards are increasingly uncommon, but still too prevalent.)

Staggered boards came into prominence in 1982, via lawyer Martin Lipton of Wachtel Lipton as a form of poison pill, at a time when managements were being threatened by “green mailers” and other corporate raiders whose purpose was to buy companies, strip out the cash, fire a bunch of people (generally, including the management) and sell the carcass piecemeal. In using leverage, these raiders were able to make a lot of money on very little invested equity. While shareholders did benefit, as an asset worth X became valued at X plus, managements were threatened; so staggered boards became a means to protect their job, without regard to the interests of shareholders. One could argue that, in preserving management, they saved employee jobs. But, to the extent the company was poorly run, that would simply buy time. For competitive forces – keeping Schumpeter’s theory of Creative Destruction in mind – would ultimately have rationalized the business. Jobs would be lost; management gone and shareholders would be losers.

The Court’s decision is important, as Delaware is home to 60% of Fortune 500 companies and 50% of all publically traded U.S. companies. As the Financial Times put it last week, Delaware courts have “generally favored a director-centric model of corporate governance over so-called shareholder democracy.”

The impetus for the decision was the rebuffed bid for Airgas by Air Products, a company followed and recommended by MCH analyst, Chris Shaw. The question is, were Airgas shareholders well served by management’s costly battle to remain independent. At the beginning of February, when the $60 initial offer was made (later raised to $65, Airgas stock was trading at $42 – a premium of 40%. In December, Air Products raised the bid to $70, but Airgas said the business was worth $78. The stock, as I write, is trading at $62.15, 11.2% below the offered price.

There have been other examples of directors putting the interest of shareholders behind that of management. Steve Kroll, who works in our office, was a director of E.F. Hutton, with a pocketful of options struck at 30, when, in the spring of 1987, Shearson offered $62.50 for the company. Management rejected the offer as inadequate. In December of that year, in the aftermath of the crash, management reconsidered, deciding the company was worth $29.50.

More recently Yahoo management, in the spring of 2008, rejected a cash offer by Microsoft to buy the company for $31.00 per share, a 66% premium. Three years later, the stock is trading at 16.37. That same spring, Electronic Arts made a $25.74 cash bid for Take Two Interactive Software. The board deemed the offer inadequate. Today, three years later, Take Two is trading at $15.69.

The argument generally issued in defense of staggered boards is that they permit the company to focus on the longer term – to not worry about the re-election of all directors every year, as opposed to just a third. Secondly, they argue, somewhat patronizingly, since directors are “insiders,” they are in a better position to know and understand which strategy would produce the better result for shareholders. However, Professor Lucian Bebchuk of the Harvard Law School has written extensively on the subject of staggered boards. A study prepared in 2005, “The Costs of Entrenched Boards” co-authored by Professor Alma Cohen, compared stocks that were public in 1990 and then looked at valuations between 1995 and 2002. They found a correlation that was “consistent with staggered boards having a negative effect on firm value.”

Yesterday, Professor Lucian Bebchuk wrote in a Wall Street Journal op-ed that the Delaware Court’s decision “represents a setback for investors and capital markets.” In the article, he does point out that the industry is trending in the right direction, as the number of S&P 500 companies with staggered boards have declined from 300 in 2000 to 164 in 2009. Still, almost half public companies continue to have them. Professor Bebchuk asks: “Why should shareholders, who have powerful incentives to get it right, not be permitted to make their own choice between selling and staying independent?” A good question.

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One of the more depressing developments, in my opinion, of the past half century has been the growing irrelevancy of the United Nations. It has become the most vivid example of what is wrong with political correctness and multiculturalism. It is sad, because the organization could be a leading light toward democracy, fairness and equality. As a manifestation of this downward trend was the decision to convene their Human Rights Council today to pass judgment on the Libyan situation. The UN Human Rights Council is comprised of 47 nations, including Libya and includes other paragons of virtuous human rights, such as Nigeria, Bahrain, Saudi Arabia, China and Russia – countries that wouldn’t recognize a human right if it demonstrated in front of their capital.

Thursday, February 24, 2011

Erich Segal, in his novel, Love Story, had one character say, “Love means never having to say you are sorry.” Whatever the merits of that sentiment (and I disagree with it), Democracy does mean having to accept the outcome of elections. It means that we have to live with results that we may not like; because the people have expressed their will. If we don’t, why hold elections? In our democracy we are fortunate because if our party loses we know there will be another election that will provide an opportunity to attempt change.

The results of the election in Wisconsin were pretty clear, no matter whether one is a Democrat or a Republican. Governor Scott Walker won 52% of the vote versus 46% for the Democrat, Tom Barnett. Prior to November 2, Democrats controlled the State Assembly 50 seats to 45. After Election Day, the Republicans’ majority became 60 to 38. In the State Senate, Democrats lost four seats and Republicans picked up four; so that an 18-15 Democratic majority became a 19-14 Republican majority – in total, a sweeping victory. To borrow a line from President Obama, Republicans won; it is their responsibility to govern based on the platform on which they ran.

No matter one’s politics, it is preposterous to believe that a democracy can function when the losers decide to vacate the premises, as fourteen Wisconsin Senate Democrats did a week ago. Making a game of their life on the run, Senator Chris Larson, sounding sophomoric at a serious moment, was quoted in today’s New York Times: “It all feels very spylike. It’s almost like a reality TV show.” It is, however, understandable for the protestors in one state to enlist supporters from out of state to buttress their position. In politics, it is also considered fair to misconstrue the opposition, as both sides can play that game, but for an elected Wisconsin legislator to hide out in Illinois to avoid showing up for a vote makes a mockery of democracy.

Debt and union rights were the principal issues in the November elections. So it should have come as no surprise that Governor Walker decided to directly address those concerns, rather than kicking the bucket down the road, as has been the recent trend. Regarding unions, the new governor asked for a vote on some specific issues – limiting collective bargaining to just wages, in other words taking work rules and benefits off the table; requiring state workers to contribute half the cost of their pension contributions, and increasing from 6% to 12%, the amount of their healthcare premiums they would be required to pay. (Exempted from these provisions would be police and firemen.) Currently, workers in Wisconsin must pay union dues or lose their jobs and the state helps subsidize the collection by using its payroll system to collect those forced dues. Under Governor Walker’s proposal, the membership requirement would end, as would state collection of union dues.

Unions, as is well known, have declined as a percent of the workforce from 20.1% in 1983 to 11.9% in 2010, as private businesses have been forced to deal with the realities of competition, or fail. Only 6.9% of private workers are union members today, while 42.3% of state and local workers are unionized. As such, public workers represent the last power base for union leaders. The stalemate in Wisconsin centers around the issues of collective bargaining, membership requirements and the collection mechanism, as Republican’s success on those issues would serve to impair union power, thereby depriving Democrats of their largest source of cash. This fight strikes at the heart of their fund raising and of union power. It is understandable that emotions are elevated. Nevertheless, that does not legitimize, in my opinion, the evasion of duty by officials elected to watch over the welfare of the state they represent.

Like many states, Wisconsin is basically broke. Its current budget is $137 million in deficit. Its pension and healthcare assets assume a 7.8% annual return, leaving the state, according to Pew Research, with an unfunded pension plan of $252 million and $1.7 billion in unfunded healthcare benefits. For years governments have avoided the ultimate consequence of under-delivering what they have over-promised. It is possible that if markets and the economy continue to perform well the problem may again be postponed, but any postponement would only be temporary; for the deficits are growing inexorably. The legislation that created this untenable situation must be addressed. Wisconsin is a test case, in this time of ‘fessing’ up to debt obligations; it will demonstrate whether state officials will stand up for the voters or surrender to the tyranny of the minority. Nevertheless, I am not especially sanguine. History suggests that, in politics, brakes are usually applied too late to avoid a crash. I hope I am wrong.

Wednesday, February 23, 2011

We have become a nation inflicted with attention deficit disorder. Real investment, a situation that requires time and patience, is unlikely to succeed when the focus of private equity investors – those who provide capital to innovators, entrepreneurs – is on an exit strategy, rather than on building a business.

Tyler Cowen, an economics professor at George Mason University, has produced a thirty-nine page e-book, The Great Stagnation, which tackles the question of why innovation in our economy has slowed, with the consequences being slowing acceleration in median income and diminished growth in standards of living. The book, as David Brooks in the February 14th issue of the New York Times http://www.nytimes.com/2011/02/15/opinion/15brooks.html, writes, “has become the most debated nonfiction book so far this year.”

Cowen references work done six years ago by Jonathon Huebner, a physicist working at the Pentagon’s Naval Air Warfare Center in China Lake, California. Huebner claims that, measured by scientific advances and U.S. patents granted per decade divided by the country’s population, innovation peaked in 1915. No one would argue that products such as electricity, in-door plumbing, the automobile and washing machines greatly improved the standard of living for millions of people. Futurologists would argue, however, that technology is developing at exponential rates – chip density, genome sequencing, internet connectivity and nanoscale machinery are catalysts for further waves of innovation, perhaps in fields that today we cannot imagine.

David Brooks puts an interesting twist to the story, suggesting that the slowdown, which no one can deny, is reflective more of a shift in values, rather than the nature of the technological change. He writes: “It could be that in an industrial economy people develop a material mind-set and believe that improving their income is the same thing as improving their quality of life. But in an affluent information-driven world, people embrace the postmaterialist mind-set. They realize they can improve their quality of life without producing more wealth.”

Professor Cowen suggests that three factors were a cause: The first was the availability of cheap land. In its early years, westward expansion in the United States became policy under the moniker Manifest Destiny, a policy that promoted (and excused) the right of Americans to seize land, first from Native Americans and, later under President Theodore Roosevelt, in the Pacific and beyond. The second factor was the abundance of what he calls “low hanging fruit.” The development of products such as the steam and combustible engines, in the early 19th century, foretold the manufacturing of the auto, train and flight in the late 19th and early 20th century. And, the third factor was the virtually universal spread of education. Cowen points out that at the start of the 20th century one in four hundred eighteen year-olds went to college. Today, it is about 40%.

There is little debate about the facts – incomes have stagnated and the rate of improvement in standards of living has distinctly slowed. The question is does this trend suggest an inexorable trend into the nether regions? My son, in a review of the book for “Seeking Alpha” http://seekingalpha.com/article/253611-book-review-the-great-stagnation, suggests that further changes are occurring. He writes: “Big societal changes begin in small increments. The internet may not be forming jobs on the scale of the auto industry in its heyday, but at least it provides an opportunity for individuals to become entrepreneurs, however small.”

Government, education and healthcare have become the dominant sectors of our economy, according to Professor Cowen. With the passage of Obamacare, all of these sectors (with the notable exception of private education) have now come under the purview of government. In the late 19th century, at the height of innovation, government (using government consumption numbers) accounted for about 5% of our economy. Today it accounts for 15-20%. Because of the way in which GDP is measured, for government cost not price is the basis. Thus Cowen writes: “The larger the role of government in the economy, the more the published figures for GDP growth overstates improvements in our living standards.”

There are, in my opinion, four factors that could reverse the trajectory that Tyler Cowen’s book describes. The first would be a slow down in the expansionary role of government. The protests we are witnessing in states across the country suggest the magnitude of the debate and the possibility of that eventuality. The second would be changes in immigration policies that would favor the highly skilled. This is an issue on which there seems to be agreement. The third would be improving basic education – substituting the “illusion” of education for the reality – and here again the seeds of reform are present, as the documentary “Waiting for Superman” so poignantly demonstrated. And the fourth, and the least visible at this time, would be a change in the tax code that encouraged investment and penalized very short term trading.

Tyler Cowen’s book deserves the praise and attention it has received. The book should be required reading in Washington; at thirty-nine pages even ADD inflicted politicians should be able to handle it. He has placed in debate issues that are critical to our future, but I also suspect that my son has pointed to a possible answer – an economy that requires fewer people to produce the same level of goods is forcing more individuals to become entrepreneurs. Self reliance is a valuable trait, one that has been missing in our consumption dominated society.

Tuesday, February 22, 2011

Matt Taibbi, in the March 3, 2011 issue of Rolling Stone asks a fundamental and unanswered question: “Why isn’t Wall Street in Jail?” A good question, but I would add a second, “Why are not some of our lawmakers also doing time in the pokey?” The country suffered a near death experience in the fall of 2008, yet Washington and Wall Street continue to operate as though very little has changed. For example, the CDS market, which bankrupted AIG and has cost the American people billions, still functions with no limits. As Mr. Taibbi writes, none of those on Wall Street who bore responsibility for the near collapse have been imprisoned.

It is not that the U.S. is shy about jailing miscreants. According to the Bureau of Justice Statistics, 7.2 million Americans, at year end 2009, were on probation, in jail or in prison. At 3.1% of the population, that represents the highest documented incarceration rate in the world. Fines have been paid, but they do not nearly compensate for the losses incurred by shareholders; nor do those fines adequately reflect the fact that taxpayers have been tapped for the misdeeds of a small but select group of CEOs, who used public companies for their own purposes.

The Press, in their quiet acquiescence, has been too often too silent on this matter. On Friday, Ben Protess writing in the New York Times declared that the $22.5 million dollar fine levied against former Countrywide Credit CEO, Angelo Mozilo, and the forfeiture of $45 million in ill-gotten gains was “a fitting outcome for a corporate executive who deliberately disregarded his duties to investors.” What Mr. Protess neglects to mention is that in the single year preceding the Company’s collapse Mr. Mozilo took $143 million and investors lost $36 billion, or 90% of their investment. Why should Mr. Mozilo be left a rich man?

Washington and Wall Street have always had a symbiotic relationship that crosses Party lines. Democratic Chuck Schumer has always been considered Wall Street’s favorite Senator. In 2008, after unions, Goldman Sachs was Barack Obama’s single largest financial contributor. Representative Barney Frank and Senator Chris Dodd were, financially, far too closely affiliated with Fannie Mae and Freddie Mac, taking in funds raised by the two GSEs and, in return, providing them cover to over-leverage and engage in transactions unrelated to their charter. As bonuses were determined by earnings, there was an enormous temptation to cheat. Between 1998 and 2003, Franklin Raines, former CEO of Fannie Mae was paid $90 million. According to a report issued by the Office of Federal Housing Oversight Office (OFHEO) in 2006, $52 million of that compensation was based on earnings from faulty accounting, yet he was only fined $24.7 million. With shareholders having lost about $60 billion in market cap (reflecting a 97% decline in the stock) and taxpayers forking over $150 billion (thus far), the fine seems piddling relative to the magnitude of the crime. Why should Mr. Raines be left a rich man?

Richard Fuld, who skippered the good ship Lehman Brothers onto the shoals in 2008, was paid $484 million between 2000 and 2007. After the bankruptcy, his net worth was, according to his own testimony, about $350 million, indicating that he was smarter than his shareholders. He even managed to sell his $13 million house on Jupiter Island, in November 2008, to his wife for $100.00. In February of 2007, Lehman stock was valued at $60 billion. By October 2008, it was worth nothing. Again, shareholders were left holding an empty bag, while the captain of the ship remains exceedingly rich. Mr. Fuld is yet to be charged. Why should be Mr. Fuld remain rich?

Mr. Fuld was far from unique among Wall Street CEOs. How can one forget Lloyd Blankfein, CEO of Goldman Sachs, claiming that his firm was doing “God’s work”? He did so while making billions for himself and his partners, but little for his shareholders, as the stock is lower today than four years ago. Regulators and Wall Street professionals regularly exchange jobs, suggesting the ties are nepotistic, not independent.

Toward the end of his article, Matt Taibbi writes: “All of this paints a disturbing picture of a closed and corrupt system, a timeless circle of friends that virtually guarantees a collegial approach to the policing of high finance.”

The capital markets are critical to our well being. It is very possible that populism will emerge in reaction to the corruptness of the system. Politicians who financially benefitted from their ties to Wall Street will be quick to swing the other way, as the winds shift. Despite their rhetoric to the contrary, too many of these people have no interest in any future beyond the next election. Debt and obligations, particularly from entitlements, threaten to overwhelm our nation. It is convenient to find scapegoats and Wall Street, having sinned, stands out as a target. The problem for our markets is that politicians do not seem to differentiate between investors and those who led these firms. About half of all Americans have exposure to stocks, through pension funds, 401k plans and thousands of mutual funds. The decline in defined benefit retirement plans (today, almost exclusively the domain of public pension funds) and the rapidly approaching bankruptcy of Social Security point to the necessity of people having to become more self reliant, in terms of retirement. That will require a vibrant, open and tax-advantaged stock market.

Wall Street has become increasingly dependent on trading strategies, as can be seen by the rapid growth of algorithmic high frequency trading platforms, a subject about which I have often written. Simultaneously, long term investment strategies have declined in popularity. Sarbanes-Oxley, perhaps well intentioned, has had the effect of reducing the number of publically traded companies. The effect has been to limit opportunities for investors (and for employment) at a time when both are needed. Money, seeking returns, has been forced overseas and into debt markets.

Thus, the on-going debate in Washington, Wisconsin, New Jersey and New York is welcome, as they are integral to the problems we face. Governors Chris Christie and Scott Walker have done us a favor, in putting on the table subjects no one wanted to address, including benefit plans for public employees that are unavailable to private workers and are threatening society. On this day, the real birthday of our first President, it is worth being reminded that George Washington was acutely aware of a similar problem. Ron Chernow, in his biography, Washington: A Life, writes that Washington had often expressed the view that “citizen’s had to feel before they saw – that is, they couldn’t react to abstract problems, only tangible ones.” We now have tangible problems and they include the plight of investors who have been given short shrift by too many politicians and by too many CEOs who have used assets owned by shareholders as their personal piggy banks.

“Perfection is attained by slow degrees; it requires the hand of time.”

Voltaire (1694-1778)

Not having much of a music sense, so shutting my eyes and enjoying the sensation, I was sitting recently in Old Lyme’s First Congregational Church, the venue for Musical Masterworks, letting my mind wander. Two violinists were playing Dmitri Shostakovich’s Duets for Two Violins with Piano in three parts. Not quite day dreaming, it occurred to me that we live in a time when technology has radically changed our lives, for better and for worse, but mostly for better. Skis, clothes, tennis racquets, cars, TV, telephones, drugs, music synthesizers, golf clubs – myriad products that we use every day have been improved from advances in technologies and the use of new materials, be they composites or rare earth minerals. Yet a violin made by Antonio Stradivari in 1710, from material available today, has never been improved upon. Why?

The nave of the church, which hosts Musical Masterworks and which was rebuilt in 1909 with the aid of artists from the Old Lyme art colony, achieves almost perfect acoustics. Musical Masterworks is a series of five chamber music concerts that have been held every year for the last twenty. The series was begun with Charles Wadsworth, the founding director of the Chamber Music Society of Lincoln Center, as artistic director. Two years ago Edward Arron, the artistic director for the Metropolitan Museum Artists in Concert, succeeded him. The artists come from around the world and have included this season Yosuke Kawasaki and Catherine Cho (violins), Marya Martin (flute), Andrew Armstrong (piano) and Randall Scarlata (baritone).

Antonio Stradivari was likely born in Cremona in 1644. Around the age of 13 he was apprenticed to luthier, Nicolò Amati, grandson of Andrea Amati the earliest maker of violins that still survive today. As Stradivari inscribed his violins with Latin slogans, they became known as Antonius Stradivarius violins. Today, those instruments made during what was considered his “golden” period, between 1700 and 1720, command prices in the millions of dollars. The highest price paid at a public auction for a Stradivarius was $3,544,000 at Christies in New York on May 15, 2006. It is estimated that instruments have sold for higher prices in private sales.

While a Stradivarius is generally considered the best violin ever made, there are have been blind tests, conducted between 1827 and the present, that question that conclusion, but in none of those tests has the sound quality of a Stradivarius ever been found wanting. Wikipedia suggests that while the techniques used in their construction have long been debated, it is known that Stradivari experimented with sizes. The woods used are known: spruce for the harmonic top, willow for the internal parts and maple for the back, strip and neck. The wood, which was stored in Venice in and under water before being used, was treated with several types of minerals; the varnish comprised a mix of natural products. There are theories that the wood used was denser than that generally available today, due to the stunted growth of trees, a function of the Little Ice Age, which lasted from the mid seventeenth to the mid eighteenth century.

Whatever Antonio Stradivari did, the result is mesmerizing: the notes that evening flowed, somberly in the Prelude, cheerfully in the Gavotte, and the Waltz made the listener believe he/she was in mid-nineteenth century Vienna.

However, lacking musical sophistication, my attendance at these concerts is somewhat akin to taking a nine-year old to see Shakespeare in the Park. It’s easy to become distracted. I sit there and let the music sweep over me. I marvel at the composers and consider their genius, as writing music of this sort must be like writing a play, only far more complicated. Each instrument is played according to the specific demands of its individual script, sometimes in tune with the other instruments and at other times alone, or in opposition. The composer, faced with an empty sheet of paper, must write the music for each instrument; he must be able to hear the tune in his mind, the sound and tune from each instrument and how they blend into a cohesive whole. Their genius is beyond my comprehension.

We live in an age where meetings on Facebook constitute a relationship and when twittering, IM and YouTube have replaced person to person dialogue. Listening to Ms. Catherine Cho and Ms. Kyung Sun Lee, their bows moving rhythmically across the strings, producing sounds that can only be described as heavenly, I bask in the wonder that technology, which has altered our lives in so many ways, has been unable to improve upon an instrument made three hundred years ago in the ancient city of Cremona. And I smile.

Thursday, February 17, 2011

At the end of World War I, the Allies partitioned the Ottoman Empire, drawing boundaries and creating countries where none existed – the result being the eastern part of the Middle East. Ever since (and probably before) the region has been a simmering pot, which periodically boils over. Following World War II, a section of Palestine was carved out as an Israeli homeland, in part to assuage the guilty feelings of Europeans who had let Germany rearm, in violation of the Treaty of Versailles of 1919, and a consequence of which was the murder of seven million Jews. Between 1948 and 1982, a hot war erupted five times between Israel and their Arab neighbors. Thirty years in this region without a hot war is a long time. A friend of mine who is Turkish-American and who spent some of his formative years in Turkey got me thinking on this subject. Thirty years of this fragile peace can be seen as a victory for the policy of Realpolitik, a concept that these revolutions are undermining. How long will this anxiety-riddled peace last?

Stability in the Middle East has been the result of an uneasy cooperation between the democratic West, dependent on the region’s oil, and the autocratic rulers of the individual countries, whose security depends on their Western friends. That duplicitous, but symbiotic world appears to be falling apart. Aging tyrants have fallen in Tunisia and Egypt and are under siege in Bahrain, Yemen and possibly even in Saudi Arabia. Further east, in Pakistan, the odd case of Raymond Davis is indicative of a troubling deterioration in the relationship between that country and the U.S. Pakistan, a nuclear power, has been an important ally in the War on Terror, as their mountainous northwest border with Afghanistan harbors Taliban and remnants of Al Qaeda. However, residents in the area in which the fighting is taking place are beginning to resent Americans who they feel have made their personal lives difficult.

Raymond Davis purportedly was working as a “consultant” to the U.S. Consul in Lahore, Pakistan’s second largest city. A former member of America’s Special Forces, Mr. Davis apparently was there on a diplomatic passport, but unlike most diplomats he was carrying a Glock. When two men on motorcycles attempted to rob him he shot and killed them. His passport supposedly gives him immunity, but tensions in the region were already high and this acted as a catalyst. The situation has put the government of Pakistan – functioning today with a President, Asif Ali Zardari, who is considered weak – in the uncomfortable position of being pilloried by its citizens if they let him go, yet being deprived of millions of dollars in U.S. aid if they do not.

Blood has already been spilt on the streets of most of these countries. The New York Times estimates that, excluding military or police, 365 have been killed in Egypt. Members of Iran’s Parliament, according to yesterday’s Times “clamored on Tuesday for two leaders of the opposition movement…to be hanged.” They have two war ships in the Red Sea, apparently headed for the Suez Canal. In Bahrain, where the American Navy’s Fifth Fleet is based, two men were killed on Tuesday and three last night. The kindling has been laid; it lacks only the spark.

Curiously, the country that could be most at risk is Israel. John Steinbeck once wrote (Travels with Charlie) that we all must have someone to blame or to hate – to serve as a distraction for our own weaknesses. When Steinbeck wrote those words, during the Cold War, the target for Americans was the Soviet Union. Israel makes a perfect foil to nations in the Middle East. Iran and Syria have called publically for its destruction; it is despised by most of the rest. Leaders who have been targeted by the student and young workers’ unrest movement may try to channel the frustration of those protestors toward a perceived common enemy – Israel. Such an eventuality would present the U.S. with a Hobson’s choice – only one possibility, to come to Israel’s defense – but with the risk that the resulting instability, bloodshed and disruption of oil would wreck havoc on economies in Europe as well as America.

Wednesday, February 16, 2011

Inflation is insidious in the way it creeps silently into our pocketbooks. Worse, inflation rewards debtors and punishes creditors. And, if you haven’t noticed, we are a debtor nation, with a government that appears uneasy about addressing entitlements, the root cause of our debt. Mr. Bernanke seems willing to accept a “little” inflation, as the price of keeping deflation at bay. And, while an annual inflation rate of 2% may seem livable, the consequences of 4% are quite different. At 4%, the dollar loses half its value in 18 years and 75% of its value in a generation. By the time my grandchildren reach my age, the dollar would have lost almost 90% of its value. Inflation is a wealth destroyer.

In the early 1980s, then Fed Chairman Paul Volcker, with President Reagan’s blessing, broke the back of inflation by raising rates to what some considered usurious levels (and induced a short but sharp recession.) It worked. The 1990s were a time of modest inflation, but by the early 2000s, with the fright of a stock market collapse and the scare from the attack by Islamic Jihadists, those lessons were lost. The Fed lowered the Funds rate from 6.5% at the end of 2000 to 1% by June of 2003, when the stock market had already begun to recover. The effect was to induce asset inflation. Home prices were an immediate beneficiary, as were commodities such as gold and oil, which had lain dormant for a decade or more. Houses became much more than a roof over one’s head; they became personal ATM machines for millions of holders, seduced by the concept that valuations were a one-way street.

Just over two years ago, in December 2008, the Fed reduced the Funds rate to 25 basis points, where it remains today. At the time, credit markets were beginning to revive from what had been a near-death experience that fall, and the economy was two thirds of the way through the worst downturn since the 1930s. Despite indications that the economy has been recovering – albeit at a slower than normal pace – the Fed has chosen to keep rates at this historically low level, using a persistent 9% unemployment rate as their excuse.

To the extent their purpose was to re-liquefy the banking sector and to inflate assets, they have succeeded. A question facing investors now is have they gone too far? While the Fed looks at CPI prices ex food and energy, because of the notorious volatility in their numbers, consumers do not. In the past two years, soybean prices are up 49%, corn up 51% and gasoline up 70%. Stock prices are up almost 100%. On the other hand, the yield on the Ten-Year has risen 80 basis points, suggesting a tempering of risk and modest renewed concerns over inflation.

With almost $10 trillion dollars in Federal debt, it is in the interest of our government to keep rates low. In 2010, interest payments, at $197 billion represented 6% of the budget. With debt continuing to increase, any rise in rates will be deleterious to a budget that the President and Congress are having trouble trimming. But, it is certainly possible that increasing debt and with inflation concerns potentially pushing rates higher, interest payments will rise substantially for the fiscal year beginning in October.

Neither the Congress nor the President wants to be the bearer of bad news, thus the dance we are seeing in Washington as each waits for the other to be the first to tamper with entitlements. How much more pleasant it is to defend programs, no matter how wasteful, than to trim, whether the instrument is an axe or a scalpel.

In an economy with growth as tepid as this one, the affects of inflation will be particularly painful, especially for lower income consumers to whom food and energy represent a larger percentage of their daily budget. Savers and the elderly will be impacted, as their costs go up and income declines. Inflation is insidious; it rewards profligacy and it punishes the prudent. And sooner or later it must be addressed.

Tuesday, February 15, 2011

The overthrow of Hosni Mubarak of Egypt, after eighteen days of civil unrest, has been welcomed in the West, as symbolic of freedom coursing through the developing world. While the Obama administration has not given kudos to President Bush for his advocacy of a Freedom Agenda, the administration’s attitude is far different than it was when President Obama’s benign neglect helped foredoom the Green Revolution, which threatened the Ahmadinejad regime in June 2009.

The problem with revolutions such as we have seen in Egypt is that, while the youth want change, the key reason they are demonstrating is that they are against the existing government, and only for some vague concept of democracy. It does seem, though, that the Muslim Brotherhood who was surely interested in a specific alternative – an Islamic state – will not get their wish. The secular Supreme Council of the Armed Forces is in charge. The question is will students and young people, like Wael Ghonim the Google executive who became the face of the protest movement, be satisfied with reform that keeps the army in charge? Will the army grant reforms that satisfy the demands of those seeking basic liberties? Or will their decision to suspend the constitution incite the type of resentment that rocked Algeria in 1992, which resulted in a decade-long war that left over 200,000 dead?

Over the past sixty years the one constant in Egypt has been the army. Ever since the summer of 1952 when King Farouk was overthrown, the army has been a critical presence. General Naguib served as the first President of the Republic of Egypt for a little more than a year before being arrested and imprisoned for eighteen years by his successor, Col. Gamal Nasser, who served from 1954 until his death in 1970. Anwar Sadat, a supporter of Nasser, served unti1 1981 when he was assassinated. It was the peace resolution Sadat negotiated with Israel that alienated much of the Arab world that likely led to his death. A Lieutenant Khalid Islambouli, after receiving approval for the assassination from Omar Abdel Rahman, the “Blind Sheikh” and a founder of the Muslim Brotherhood in Egypt, was accused and summarily executed. Hosni Mubarak and dozens of others were wounded in the attack.

In the wake of Mubarak’s resignation, the Supreme Council has assumed responsibility for running the country, promising to hold elections in about six months, roughly when they were scheduled anyway. The difference being that Mubarak’s son will not be a candidate. Whoever does, though, is likely to come from the military and certainly will be approved by them.

James D. Le Sueur, Professor of History at the University of Nebraska, points out in a recent article in Foreign Affairs that colonialism, or rather the end of it, was the determining factor in the lives of many leaders such as Hosni Mubarak in the last half century. Mr. Mubarak was 24 years old at the time Farouk was deposed and the British left. Many of these leaders felt they had fought so hard for liberation that only uncontested authority would prevent a return to the past. These leaders suffer from what Professor Le Sueur refers to as postcolonial time disorder (PTD), meaning that “they still subscribe to an out-of-date philosophy of governance…They have a Manichean inability to think outside the logic of totalizing state power.”

With the ubiquity of social networking, it is becoming virtually impossible for an autocratic ruler to suppress his people for any extended period of time. The Foreign Minister of Jordan, for example, claims that among his population of six million 25% are Facebook users. The Egyptians’ future depends on whether a Mandela appears, or whether the new leader will be another version of Mubarak. Nelson Mandela was a man who understood, as Professor Le Sueur points out, the dangers of PTD. However, given the years that have passed since colonialism, any new leader will be one whose philosophy and character were formed by the Republic of Egypt, without memory of the British. The people will vote when elections are called, but a question for Egyptians is will the Supreme Council of the Armed Forces submit or affirm the names of the candidates?

The United States has a lot riding on a stable Middle east; so presumably it would like to influence the outcome. Our $1.55 billion aid package – Egypt, after Israel, is the second largest recipient of U.S. foreign aid – surely provides some leverage, but it will be the Egyptians’ and the army’s decision. The path to freedom is often bloody; it takes time and luck, and is never easy.

As investors, the situation adds to uncertainty at a time when markets have become increasingly complacent.

Monday, February 14, 2011

While Hosni Mubarak’s flight from Egypt dominated the weekend’s headlines, a report released by the Obama administration will have more direct impact on most people in this country. That report, “Reforming America’s Housing Finance Market”, clearly states that Fannie and Freddie strayed from their core mandate to pursue riskier business, and it points out that their “profit-maximizing structure undermined their public mission.” It essentially calls for the unwinding of the two GSEs, though one option – the third – suggests they could return under new names.

Embodied in the report are sensible recommendations to avoid future calamities: requiring higher down payments, stricter underwriting standards and promoting the concept of renting. While the report is careful about prejudicing their preferences, in suggesting that the highly popular 30-year, pre-payable mortgages without the presence of a federal mortgage company may not survive, they seem to favor option three. That option envisions a “group of private mortgage guarantor companies that meet stringent capital and oversight requirement…” – new born Fannies and Freddies?

The report offers three options – each incorporating increasing degrees of government involvement – that should be considered within the context of four key factors: access to mortgage credit, incentives for investment in housing, tax payer protection and financial and economic stability. It concludes that government should play a role in the future mortgage market, but striking a balance: “Creditworthy Americans should have broad access to credit, but not at a cost of excessive taxpayer risk, distorted markets or financial instability.” Of the three options offered in the report, the first has the government playing the least intrusive role.

Government’s involvement in markets usually results in the misallocation of capital. Capital, in such cases, does not flow based on return versus risk; it flows at the whim of Congress. A second problem, a consequence of Dodd-Frank, is that “too big to fail” financial institutions will become even larger, including those that may offer mortgages.

Regardless of what happens, the economy and the market, in fits and starts, are beginning to adjust to a future in which home price appreciation will be far more modest and homes will no longer be a source that can be tapped for consumer expenditures. Today’s article in the New York Times, “Housing Market Looks Sickest in Cities That Once Seemed Immune,” points to the continued financial risk of home ownership.

The government’s report provides a litany of causes for the meltdown; however, it does not discuss the symbiotic, and far too cozy, relationship between management and certain members of Congress. It does not put any blame on consumers who, lemming-like, often pursued mortgages beyond their means, only arguing that they need the protection afforded by the Consumer Protection Act. The report soft-pedals its criticism of the GSEs, in pointing out that delinquency rates on loans held by other banks were “far higher than on loans held by Fannie Mae and Freddie Mac,” without explaining that limits on the size of mortgage guarantees prevented FNM and FRE from participating in many of the jumbo-balloon mortgages that wrecked so much havoc.

On the other hand, as the report makes clear, far too high leverage, unrestricted salary and bonus payments made management incentives akin to those in the private sector; while risking cheap capital supplied by unsuspecting taxpayers. Some of the excess profits earned went into the pockets (or PACs) of those who were doing the regulating, a practice in the private sector that would be termed bribery.

For a time shareholders benefitted, but in the end they lost money – at least those who stuck around. The real winners were management who were grossly overpaid based on inflated numbers and politicians who saw these entities as honey pots.

The relationship between business and government, in my opinion, should be akin to that of a sports meet. The rules and regulations should be drawn up by government based upon the precept of fairness. The referees/regulators should be government. But players should represent the private sector. A problem, which the report does discuss, is that Fannie and Freddie had the “implied” backing of government, thereby reducing their cost of capital, which gave them an unfair advantage when competing against the private sector. Misallocation of capital is always a problem when the nose of government reaches under the tent of capital markets.

Institutions, such as Social Security, Medicare and Medicaid have long been considered as having “third rail” characteristics, given their ability to destroy any politician who tampered with them. Fannie and Freddie, until recently, had taken on the same mantle, as politicians from both parties pushed homeownership as a “right”. It has taken the de facto bankruptcy of the two GSEs to get government’s attention. Hopefully, a lesson will be learned, as Congress grapples with yet another new entitlement – healthcare. The lesson will not be learned if Fannie and Freddie re-emerge in disguise, and/or if Congress leaves untouched other existing entitlements.

Friday, February 11, 2011

While it’s unlikely that the Germans will be singing “Deutschland, Deutschland Über Alles,” as they descend on Wall and Broad to consummate the merger of the Deutsche Börse and the New York Stock Exchange, it will mark the demise of the foremost symbol of American capitalism – assuming regulatory bodies on either side of the pond do not nix the deal. The end of the Exchange, as many of us knew it, occurred in March 2006 when, in a reverse merger, seat holders of the NYSE completed a deal with Archipelago Holdings, then a public company, and the stock began to trade under the name NYSE Group, symbol NYX.

Change at the NYSE has been evolving for years. Jason Zweig, in an article in yesterday’s Wall Street Journal, which was both amusing and informative, traced some of those changes back to the latter half of the 19th Century. More recently, lower commission rates, trading in pennies as opposed to eighths, and algorithmic programs caused volume to accelerate geometrically, demanding far faster computers. Speed of execution became paramount to traders. The effect was to transform the Exchange from a relationship-centric auction market to an execution service center.

When I started in this business, in September 1967, average daily trading volume was about ten million shares a day. By 2006, it was closer to 1.6 billion shares a day. Today NYSE volume has been averaging closer to one billion shares a day, while composite volume in NYSE listed shares totals five times that number. The Exchange has been losing market share. The need for faster execution had been the genesis of Archipelago. With its computers able to match and transact orders in seconds, NASDAQ has taken business from the NYSE. Today, its volume exceeds that of the Exchange. The NYSE either had to change or die. They chose to change.

The front page article in yesterday’s Wall Street Journal, suggests that global stock listing and U.S. stock trading would be based in New York, global derivative trading would be led from Frankfurt, while Paris would host the technology arm and European stock trading. The company would be incorporated in the Netherlands, with its headquarters split between Frankfurt and New York. The NYSE Euronext chief, Duncan Niederauer, would become CEO of the new entity. However, the authors write: “To avoid nationalistic concerns over the name, one idea is to avoid using the word Deutsche or the acronym NYSE, said one person familiar with the plans, who stressed that no decision has been made.” That, in my opinion, would be an unfortunate outcome.

The future is always unknowable and comprises changes most of us cannot envision. However, there are iconic institutions that transcend our individual lives. The New York Stock Exchange has been around since 1792, when George Washington was President. Its history is notable and marks the unfolding of American history. The building was declared a National Historic Landmark in 1978. It survived a fire in 1835; on September 16, 1920, in a horse drawn cart, a bomb exploded outside the Exchange killing 33 people and the horse. In 1967, Abbie Hoffman, one of the “Chicago Eight”, led a group of “yippies” to the visitor’s gallery where they threw dollar bills and paper onto the floor; it was the scene that many of us remember when the Averages dropped 22% on October 19, 1987. And, most famously of all, we recall that it reopened after being closed for only four days following the Islamic Jihadist attack on September 11, 2001. As my friend Vince Farrell wrote in his yesterday’s commentary, Wall Street Knows the Price of Everything, “There are some things that should not be measured by numbers on a spread sheet.”

For decades, money has flowed around the world, alternately chasing yields and safety. Algorithms are programmed to search for price discrepancies and then set to pounce when they appear. Since competition is intense, it is often he who is fastest wins. Technology is expensive and size provides advantages, the consequence being the mergers we have seen and will continue to see. As well, valuations are lower. The price of NYX is a third lower than it was when five years ago it first began to trade.

However, the deal needs the approval of at least three U.S. regulatory bodies: the Justice Department, the Securities and Exchange Commission and the Committee on Foreign Investment. As the combined business will control something like 85% of all European derivative trading, there is some speculation that some of those operations may have to be spun off. Regardless, for most U.S. investors there should be no visible change in the way orders are entered, executed and reported.

Nevertheless, the sale is a sad commentary. The U.S., for the nonce, remains the world’s leading economic and financial power. Unfortunately, regulations such as Sarbanes-Oxley have either prevented smaller companies from going public or chased IPOs offshore. The Wall Street Journal, in today’s lead editorial, points out that last year there were 171 initial public offerings in the U.S., but there were 1,295 companies that IPO’d overseas. Our rules and regulations risk placing the country at a competitive disadvantage at a time when global competition is becoming increasingly intense.

To lose an icon is always sad. To lose the icon that symbolizes the strengths, hopes and opportunities for millions of actual and aspiring investors and entrepreneurs is especially sad. Capitalism built this country; it created standards of living that were the envy of the world, driving immigrants to our shores; it paid for all the institutions we value so dearly – museums, universities and stadiums. It is not so much the loss of the Exchange that is difficult to bear; it is what the loss symbolizes and the cultural change it indicates.

Thursday, February 10, 2011

Democracy gets a bad name when the term is hijacked by greedy, unscrupulous men who once condemned the evil of colonialism and the victimization of Communism, while extolling the virtues of democracy, but all the while exploiting their own people in a manner that makes the British appear novices.

An abundance of resources and a quote/unquote democratic government does not assure wealth for its citizens. According to the CIA Fact Book, Nigeria is the fifteenth largest oil producing nation in the world. Writing in the Winter 1979/80 issue of Foreign Affairs, Professor Jean Herskovits wrote that as of October 1st 1979 Nigeria had become the world’s fourth largest democracy. Yet 64% of the population today lives below the international poverty line of $1.25 per day. However, and in contravention of common expectations, Lagos (Nigeria’s former capital and largest city) ranks as the world’s 32nd most expensive city for expatriates, according to the Mercer Cost of Living Survey for 2009 – ahead of Madrid and Brussels.

Despite the nation’s wealth of oil resources, very little has trickled down to the people. The case of the missing petroleum dollars was the subject of an article by Adam Nossiter in yesterday’s New York Times. At the end of 2008, according to Mr. Nossiter, $30 billion sat in Nigeria’s Excess Crude Account. By the beginning of 2010, the account was worth $300 million. He writes that perhaps $5 billion to $8 billion was spent on “so far unfruitful efforts to upgrade Nigeria’s feeble power output.” But the rest, “some $22 billion remains largely unaccounted for.” What Mr. Nossiter leaves unsaid is the indubitable fact that the money resides in Swiss banks, in the names of Nigerian government officials.

Certainly, the money has not made its way to the general populace. In terms of population, Nigeria is the eighth largest country in the world. (Lagos, with eight million people, is the same size as New York.) It is the fifteenth largest oil producer in the world, with a reserve life of over thirty years, yet life expectancy is 48 years and, in terms of infant mortality, the country ranks 96 in the world.

In enriching themselves while impoverishing their people, these so-called leaders have committed a crime that makes Bernie Madoff appear a choirboy. Yet, their exploits go largely unreported in the Press, or unmentioned by our government – in part because of the cheap energy they export to the West. Unfortunately, what is true for Nigeria is also true for Egypt, Haiti and a host of other nations, functioning under the flag of democracy. Colonialism got properly condemned and Communism was deemed unacceptable to the West, again rightly so; but I would submit that these people would have been financially better off had the British never left.

The Deepwater Horizon spill paled in comparison to what has been happening in the Niger delta every year for the past forty. Life expectancy in the immediate region has declined to under 40. Between 1976 and 1996, it is estimated that 2.4 million barrels of oil contaminated the environment. Spills in the delta continue at a rate of over 300 a year. Some expect that the worst is yet to come, as the oil companies will be extracting oil from more remote and difficult terrain. The planet would be better served if our government would permit greater leniency in letting our oil industry, operating under our regulations and our safety standards, drill in the Anwar, off the continental shelf and other places onshore. Yet we export the exploration and drilling to those countries where bribes replace regulation. When blame for spills is assigned, it falls exclusively on the oil companies and certainly they are part of the conspiracy. But the real fault is with the system – our country for looking away and not exploiting our own resources to become more independent, the oil companies for ignoring basic conservation standards and a political system in Nigeria, rife with corruption, masquerading as a democracy.

Wednesday, February 9, 2011

The last time the DJIA had a daily move of more than one and a half percent was December 1. (The S&P 500 declined 1.7% on January 28, but the Dow Jones fell 1.38%.) Since the first of December, the Averages have risen eight percent in a remarkably stable fashion. We have to look back to the first half of 2007 to find a similar period of such low volatility. Complacency was certainly prevalent at that time, despite forebodings of inclement weather. The question is: in this time of low volatility, has complacency reappeared?

The Federal Reserve has kept the Fed Funds rate at 25 basis points since December 16, 2008. The Fed began lowering rates on September 18, 2007 and persisted for the next fifteen months. (The Discount Rate was first lowered preemptively on August 17 of that year.) They have chosen to keep their foot on the pedal because unemployment remains high and because Mr. Bernanke continues to worry about the prospect for deflation, despite indications that the economy is recovering, though admittedly at a below average rate. During the same time, the Fed’s balance sheet has expanded by $1.5 trillion and government debt by almost $5.0 trillion. (A cynic would observe that low interest rates serve he who is issuing debt, while harming the prudent saver.)

Some of that money has gone into assets, fueling the price surge in commodities, stocks, bonds and bank loans – a goal of the Fed. Stock prices are now up 98.6% since bottoming on March 9, 2009. The decline and the first year of recovery saw high levels of volatility. During 2008, for example, there were 116 days when daily volatility of the DJIA exceeded 1.5% – up from 51 days in 2007, of which 45 days fell in the second half. During 2009, there were 61 such days, of which 47 were in the first half. Last year was a more normal 33 days.

Despite the Fed’s activity, Treasuries have fallen since year-end, as have Investment Grade Corporates. However, stocks, since the end of December, are up 5.3% and the CBOE has risen 4.0%, despite gold being down 4.1%.

Risks always confront investors. Today we have our share – persistent high unemployment, federal and state debt, unfunded pension and health plans, sovereign risk, excessive regulation, the Middle East and East Asia (North Korea) and the possibility (probability) that rates go higher. All of these, with the exception of the latter, are discussed ad nauseum in the Press.

Over the past ten or so years, the Fed has been late to react. For example, despite the tech-internet bubble beginning to deflate in March 2000, the Fed did not lower rates until January 2001. The stock market bottomed in October 2002, yet the Fed continued to lower rates into June 2003 and only began to increase them in June 2004. Despite rapidly rising home prices in the mid 2000s, the Fed finally raised the Funds’ rate to 5.25% in June 2006, but 125 basis points below where they had been in the summer of 2000. In my unprofessional opinion, they are keeping rates too low at present, helping to fuel asset prices, including equities and abetting complacency.

The difference, in my opinion, as regards the sense of complacency today versus four years ago is that four years ago few commentators were talking about the situation. Today it is the subject of numerous market seers. The stock market had made its low in the fall of 2002; four years of good performance dulled the critical eye of most investors, lulling them into ignoring warning signals. We also know that that calm preceded one of the greatest financial crises in history – an event, in my opinion, unlikely to be repeated, at least over the foreseeable future, despite the plethora of risks we discuss daily, in part because that recent experience is so deeply embedded in our psyche.

So, I conclude that we must be conscious of the decline in volatility and the complacency it might portend. I see it as an amber light, a shot across the bow. There is little question that performance over the next few years will be substantially below that of the last two years – an extraordinary period in financial markets, just as the preceding two years had been. But I also don’t believe the markets are selling at multiyear highs. After all, despite the almost 100% returns to stocks over the past two years, the S&P 500 is still selling 15% below where it was eleven years ago. And, in my opinion, we are not Japan.

Tuesday, February 8, 2011

While I would have preferred a different venue than Munich, I applaud and give credit to David Cameron, Britain’s coalition Prime Minister for the landmark speech he gave condemning multiculturism. Too often, political leaders, afraid of offending potential voters or fearful of being accused of racism, have tip-toed around the question of being tolerant of intolerance.

While the United States does not have the same problems of assimilation common to Europe, we do suffer from political correctness, an attitude which creates its own problems like permitting immigrants, especially Hispanics, to study in their own language, disadvantaging them when they get out of high school in the search for a job or in applying to a university.

European multiculturism emerged from the precepts of well-intended liberals, who felt it would be wrong to impose Western values on those from different cultures. However, its consequence was to consign those immigrants to communities that became segregated, which made assimilation difficult, if not impossible. As David Cameron said, “To oppose multiculturalism is not to demand the extinction of other cultures. It is to state the obvious: that the laws, conventions and customs which govern a society must be the same for all members.” For example, in Britain, laws and customs provide “equal rights for men and women and they protect children against exploitation by child marriages.” If that offends Muslim culture, so be it. If they choose to live in the U.K., they should abide by the laws and customs of their adopted country.

Some have accused the Prime Minister of fomenting Islamophobia. However, to equate his remarks with those from extreme right-wing groups, like the anti-Islamic English Defence League or the British National Party, is disingenuous. It serves no one, other than extremists who use segregation, and the hate it instills, to further their own cause.

Mr. Cameron went further. He suggested that a society that is open and tolerant must be honest. He called for a “muscular liberalism.” “A genuinely liberal community does much more; it believes in certain values and actively promotes them…this is what defines us as a society: to belong here is to believe in them.”

In 1964, at the Cow Palace in San Francisco, Barry Goldwater, in accepting the Republican nomination said: “I would remind you that extremism in defense of liberty is no vice. And, also, let me remind you that moderation in the pursuit of justice is no virtue.” Similarly, one could say about European multiculturalism: a muscular defense of western liberal thought is no vice, while apathy toward the intolerance of others is no virtue.

Monday, February 7, 2011

Nobody fell on Friday night. That shouldn’t be news, except that four actors have been injured on the set of Spider-Man since previews began on November 28. Before the curtain went up, we were informed that there might be delays or stoppages. There were none. But on Sunday there were two such instnaces – once when the Green Goblin was suspended for a few minutes, dangling from a wire over the audience in the orchestra; the second a minor technical problem with sound. The official opening was supposed to be on the 7th, but has been pushed back five weeks until Tuesday, March 15.

The show has been lampooned (The Onion) and spoofed (Conan O’Brien) and graced the cover of The New Yorker (four spider-men, bandaged and in bed in a hospital ward,) yet people flock to the Foxwoods Theatre, the only one on Broadway large enough to accommodate the acrobatic stunts. Perhaps they come because they want to see an accident. (Joan Rivers, according to a piece in Saturday’s New York Times, told director, Julie Taymor – “The Lion King” – “Hire a stunt person to fall on someone every three or four weeks – that’ll keep audiences showing up.”

http://www.nytimes.com/2011/02/06/theater/06spider.html?_r=1&ref=patrickdhealy. My guess is they come become of the originality of the show and the excitement of the stunts.

As one who could not wait for the official opening so bought his own ticket, Charles Spencer, theatre critic for London’s The Telegraph, was disappointed and gave the show thumbs down. http://www.telegraph.co.uk/culture/theatre/theatre-reviews/8306871/Spider-Man-Turn-off-the-Dark-the-not-so-super-hero-of-Broadway.html.

My reaction was different. I enjoyed it and think my grandchildren will as well. The show combines the sounds of a rock concert – not surprisingly, as Bono and The Edge provide the lyrics and the music – with the acrobatic feats of a circus. None of the songs seemed memorable and I would have preferred that the director cut another fifteen or twenty minutes from the show, but that did not detract from the magic of the stunts, the impressive design of the sets and the creativity of the costumes. It is not a show that depends upon great acting skills; after all these are cartoon characters. Nevertheless, Patrick Page as Norman Osborne/The Green Goblin was perfect as a campy, over-the-top villain, and I thought that Reeve Carney as Peter Parker and T.V. Carpio as Arachne were particularly well cast. To the extent that Broadway faces competition from myriad sources, enlivening audience experiences becomes critical to its future. A new genre is perhaps being created. You have to be there. The show cannot be replicated on any other medium. Spider-Man and the Green Goblin swinging out over the audience, in an arc or in complete circles, rising and falling, are spectacles not to be missed – of course better when they stay aloft.

There is a Dickensian quality to healthcare in America. “It [is] the best of times; it [is] the worst of times.” We have the highest quality modern facilities and the best trained doctors in the world. Yet we have the most cumbersome, archaic billing and payment processes imaginable. Additionally, we have a system under which millions of people have no insurance and the cost of covering those with preexisting conditions precludes many of them from any coverage.

In the most recent issue of Perspectives, the publication of my son Sydney’s firm Lyceum Associates (http://www.lyceumassociates.com/), he describes the current reimbursement schedule. He includes a formula, which is used to determine the fee paid to a doctor for a specific procedure, utilizing the Resourced-Based Relative Value Scale that sets the pricing that Medicare uses in determining fees. The formula is used to calculate the fee for a service [Z]. That service could be an appendectomy, a heart transplant, or a routine office visit; the formula to solve Fee [Z] is as follows:

RVU[Z] = Relative Value Units for the service [Z]
GPCI = Geographic Price Index for the service [Z]
PE = Physician Practice Expenses allocated for the service [Z]
PLI = Professional Liability Insurance Premium allocated to the service [Z]
CV = Conversion Factor – the dollar amount Medicare pays for one overall RVU

As my son writes, “Uh? Maybe that makes sense to a Princeton economist – or a PHD in mathematics or, for that matter, to a Wall Street quant,” but the eyes of normal people would glaze over.

This is what happens when the government intercedes in markets and we do not allow consumers and providers to price services. And, in many respects, it is at the heart of the antipathy people feel for the newest entitlement – HR 3962, the Affordable Health Care for America Act.

While the issue of healthcare in America is complex, there are some simple steps that could be taken:

1) Insurance companies could be allowed to compete across state lines.
2) People could be permitted to buy the coverage that fits their specific needs, including high deductible plans, as they do with their homeowners and auto insurance.
3) Congress could impose limits in medical malpractice suits.
4) Small businesses could be encouraged to band together to reduce their costs.
5) Health Savings Accounts could be encouraged, allowing people to pay everyday costs out of their own pocket, reserving insurance for catastrophic experiences.
6) Whatever program is designed should be one that Congress adopts for its own purposes.

Permitting more competition among insurance providers and allowing people to purchase plans that fit their individual needs, while encouraging people to pay for normal costs out of their own pockets, should bring overall costs down, allowing government to provide support to those unable to get coverage. Some of these suggestions were mentioned by Mitch Daniels, governor of Indiana, in today’s Wall Street Journal. The current system, which traces its origin to postwar America, encourages overconsumption and excessive pricing. It cannot last.

The three entitlement programs – Social Security, Medicare and Medicaid – today consume about a third of the Federal budget. That is expected to grow to about 50% over the next couple of decades, and the trend will persist. The adoption of Obamacare has only made matters worse. George Melloan, a former deputy editor of the Wall Street Journal and writing in Friday’s issue made the point that the real reason 26 states joined in Florida’s suit to nullify the law is because, “The states can’t afford it.” Estimates are that states will be required to add 15 million to 20 million people to the Medicaid roles, a system that is already causing enormous pressure on state’s budgets.

Nancy Pelosi famously said back on March 9, 2010, before the bill was passed: “But we have to pass the bill so that you can find out what is in it, away from the fog of the controversy.” The bill was passed and signed into law. The fog has been lifted (or at least some of it) and the complexities and the costs are there for all to see. Healthcare needs should be addressed, but they must be done so in a manner that provides the consumer a strengthened role in terms of prices paid for services rendered.

Friday, February 4, 2011

Political instability, in countries with repressive regimes, may be the new reality, a consequence of online social networks that reach millions of households in countries ranging from Iran to Tunisia, from China to Egypt. The thinking being that once the power of a ubiquitous communication network has been unleashed, there is no turning back. Daniel Henninger makes such a case in yesterday’s Wall Street Journal, “Stability’s End.” But the answer may not be so clear or so simple.

Marko Papic and Sean Noonan, writing in Stratfor, point out that dictatorial regimes can use social media for their own purposes; “The most effective way for the government to use social media is to monitor what protest organizers are telling their adherents either directly over the Internet or by inserting an informant into the group.” Services such as Facebook (500 million users), Twitter (200 million users) and YouTube (50 million users) may also be used to spread misinformation. They point out that authorities have monitored both Republican and Democratic conventions, as well as G-8 and World Trade Organization meetings. In some respects, it seems like verification of George Orwell’s novel, 1984, which was a chilling, fictional precursor of an omnipotent and omniscient government with devastating results to its citizens.

Social networks are the relationships created between people. They have existed since humans bonded in communities. Fraternal organizations are prominent examples. Online social networking sites are similar in purpose, but very different in actuality. Relationships are established between people with a common cause, but who do not necessarily really know one another – or they only know whatever information the member has elected to provide. In that respect, they can be used for nefarious purposes, an example being Philip Markoff, known as the Craigslist killer. Sites like YouTube have the unfortunate consequence of sating the narcistic urge among those (mostly the young) who like to watch themselves. It also provides a venue for extremists of all persuasions, likely abetting the divisiveness we all rue in today’s political world.

Most people in the West cherish the relative stability of the governments we enjoy. Many see the Internet as a means to help destabilize authoritarian regimes. The effect, however, may be to do exactly the opposite, at least over the next few years – to destabilize democratically-elected governments, and to send authoritarian regimes scurrying to shut down the Internet, as China did in July 2009 in the Xinjiang Autonomous Region and as Egypt did for the entire country one day last week. The truth is no one really knows what the consequences will be. As Mr. Henninger writes, “All the new political energy that Shockley’s (William Shockley, the American physicist who co-invented the transistor) tiny transistors unleashed has to go somewhere.” The wealth of information and the ability to communicate almost instantly can be channeled for good or for evil.

Democracies, with their defense of individual liberties, are not efficient, which is one reason they are shunned by people like Mr. Mubarak. (As an aside, according to Bloomberg this morning, Mr. Mubarak lends proof to the misconception that one must work in the private sector to accumulate wealth. Despite a career spent in the army and politics, he has a net worth estimated to be between $30 billion and $70 billion.) Efficiency is a goal of dictatorships and, as long as repression works, the trains run on time. On January 27, the day Egypt shut down the Internet and riots in the streets persisted, President Obama did a YouTube interview. He rightly compared social [online] networking to universal liberties, such as freedom of speech.

While social networking may have played a big role in the recent turmoil in Tunisia and Egypt, it is worth remembering that the most unusual and successful revolution in history was the American – unusual, in that its leaders were the financial and social elite (those that had the most to lose should it fail) and successful, in that two hundred and twenty-two years after the first American president was elected the country retains its position as the economic and military leader of the world.

As a new medium, no one really knows the long term effects of online social networking, but repressing the outlets that allow people to vent never work. Many will do foolish things, acts and words they will later regret, but worse is the regime that allegedly protects people from themselves. Intelligent, inquisitive people everywhere have a thirst for information; it is why totalitarian regimes never last, and it is why muffling the internet will not work over time. Destabilization of these regimes, with all its consequences to the advocates of Realpolitik, is preferable and ultimately inevitable. However, in the short term, the risks are that totalitarian states pervert these networks for their own purposes and that, in the U.S., they further encourage polarization.

Wednesday, February 2, 2011

“The Economy Picks Up – States Benefit, But So Does Risk of Inflation”

February 2, 2011

When the Congressional Budget Office, or its equivalent within state governments, project the effect of new programs or tax changes on their budgets, they are required to use the data supplied them, which is generally politically motivated (i.e. Healthcare Reform) and they utilize static accounting, which does not allow for behavioral changes. Not surprisingly, the data supplied tends to favor the parties introducing the legislature.

On the other hand, as economies recover, revenue projections can be misleading in a positive way. (This phenomenon is not unlike analysts who tend to be too positive as earnings and markets cyclically peak and too pessimistic as earnings and markets cyclically trough.) Official forecasts do not allow for worsening or improving economies. It is the way the numbers must be calculated, for otherwise optimism, a common infliction of politicians, would always prevail. Nevertheless, while the long-term outlook for most states “is still ominous,” state officials had to be encouraged with the release yesterday of a report from the Rockefeller Institute of Government indicating that tax revenues strengthened in each of the four quarters of 2010 – up 6.9% in the fourth quarter. However, and despite that GDP is now at record levels, tax collections continue to lag where they had been three years ago.

For almost thirty years, state revenues steadily increased. In 2008 and 2009, they declined – the first such instances since state budget officials began tracking the numbers in 1979. Thirty years of gradually increasing streams of revenues created an attitude of imperviousness among budget officials, as to potential problems, and complacency among the people. It created a sense that any over-spending in one year would be bailed out in the next. While it is pleasing to read that tax collections are up, and a continuing improving economy should augment that trend, tax collections for the 41 states tracked by the Rockefeller Institute are still 0.8% below where they were three years ago. Spending is only now being curtailed.

It has long been obvious that the least painful method of extrication from the budget mess is to grow the economy and let the increased revenues reduce the deficits. In part, this is the thinking behind the numbered QEs the Federal Reserve has been promoting, a task which Chairman Ben Bernanke might claim is algorithmic, but which Dan Pink, author of Drive would likely characterize as heuristic – think left brain versus right brain. Inflate the value of speculative assets (stocks, commodities, etc.) and assume that a pick up in personal confidence will result in an increase in consumer purchases. The risk to this program is that while the value of risk assets is inflating, “safe” assets (Treasuries and the U.S. Dollar) are being deflated, as the dollars required to buy and carry each asset increases. Ultimately, this program risks emulating the 1970s stagflation – a time of below average economic growth, persistent unemployment, high inflation and high interest rates.

Perhaps we will get lucky.The economy may recover faster than expected. Mr. Bernanke may be able to orchestrate a change from QE to QT (Quantitative Tightening) smoothly and trouble free.It is “a consummation devoutly to be wished.” But the longer rates stay artificially low and the higher commodity prices rise, the greater becomes the risk to the economy and the potential for inflation/stagflation.

Tuesday, February 1, 2011

Professor Tyler Cowen of George Mason University wrote a piece for the New York Times on Sunday past, in which he provides a dark view of American exceptionalism, as it applies to inventions that both advance living standards and increase average incomes. The article, titled “Innovation Is Doing Little for Incomes”, argues that while “America produces plenty of innovations, most are not geared toward significantly raising the average standard of living.” He cites the example of his mother who was born in 1905 and the widespread adoption of inventions such as “electricity, the automobile, flush toilets, antibiotics and convenient household appliances.” He contrasts that period with todays’ innovations.

Most inventions are processes, not eureka moments; one creation often builds off the last. Their adoptions often take years, if not decades. The first gasoline engine was invented in the 19th Century and people were playing with electricity in the 18th Century and earlier. The first telegraph sent, in 1837, was dependent on electricity, yet a hundred years later almost half the population of the U.S. would not have electricity. The first flush toilets – gravity fed – were installed in mid 19th Century English homes. Even in my youth, one hundred years later in rural New Hampshire, outhouses were not uncommon. Automobiles only became ubiquitous in the 1950s, almost fifty years after Henry Ford introduced the Model A in 1903. It took years and strong economic growth for these inventions to morph into usable and everyday products. Despite the advent of cars and trucks, by 1930 there were still 187,000 horses in New York City, most used for work, not ridden for pleasure. The process of adoption is slow and uneven, and depends upon economic conditions. Even Mr. Cowen concedes: “Scientific progress has never proceeded on an even, predictable basis.”

The professor writes of the period – 1947 to 1973 – when inflation adjusted median income more than doubled. He adds: “But in the 31 years from 1973 to 2004, it rose only 22%. And, over the past ten years, it actually declined.” What he doesn’t explain is that 1947 was two years after the end of a world war, which embroiled Europe and Asia for five years, and eighteen years after the world was catapulted into a world-wide depression following the crash of the U.S. stock market in October 1929. If there ever was a time for incomes to grow, for comparisons to be easy, that was it.

I would take exception with Professor Cowen when he suggests that unique to this period “when there have been measurable monetary gains, they have often been concentrated among a small number of company founders, as with, say Facebook.” He is right; today’s innovative products have created concentrated wealth, but that has always been the case. And it is the way things should be. Has Mr. Cowen forgotten about the great fortunes of the Rockefeller, Ford, Mellon and Carnegie families? And, of course there are always exceptions, such as Charles Goodyear who invented the vulcanization process for curing rubber, yet died penniless.

The last few years have witnessed a revolution in information accessibility and communication. We are still in the process of understanding the full effect of these innovations, but they already have had important consequences for universities, and media and financial services businesses. There will be others affected, both positively and negatively as the process of creative destruction takes place. Just because new companies and industries that will feed off these innovations are not readily visible does not mean they will not come into existence.

Innovation depends upon the study of science and mathematics, as President Obama pointed out in his State of the Union, but it also requires individuals willing to take risks and it needs venture capitalists to financially back those individuals – characteristics that may not be unique to America, but are certainly present. Innovations take time to assimilate. The first four cylinder car – the Locomobile – was built in 1902. Yet it took until the early 1950s for cars to become ubiquitous. The first steam-powered engine was a water pump designed by an Englishman, Thomas Slavery, in 1698; yet it would be over a hundred and nine years before Robert Fulton’s Clermont carried passengers up the Hudson River under steam power. And, while it is true that inflation-adjusted median income has declined over the past ten years, such times have historically given way to periods of increases.

Innovation is critical to progress, and while we should never become complacent with our situation, we may not be as badly off as doomsayers claim. Adam Segal, in his book Advantage, cites a fascinating statistic: “In a November 2009 poll conducted by Newsweek and Intel, 81% of Chinese, compared to 41% of Americans, believed that the United States was staying ahead of China.” Mr. Segal concludes, “Perhaps we should be more confident of our future.”